Excess Remuneration, Governance, and Risk-Taking in Islamic Banks

Abstract

We comprehensively investigate the impact of remuneration on the governance of Islamic banks pertaining to the board of directors (BOD), Shariah supervisory board (SSB), executives, and the chief executive officer (CEO). The research in this area is still muted, especially using samples of Islamic banks and involving all board member types. Using the hand-collected data of dollar remuneration on those board members, we estimate their ‘normal’ remuneration, and we find that all board types, including the CEO, are over-remunerated from USD 20,790–305,920. However, in further investigation, we find that the excess remuneration in the directors and SSB favours the Islamic banks, particularly to lessen the risk-taking incentive. Our result highlights the importance of Islamic banks' two-layer governance system, which has a role in preventing excessive risk-taking behaviour. Supporting the ‘efficiency wage hypothesis’, the good remuneration design for the directors and Shariah scholars will attenuate the agency problems in the context of Islamic banks. Regarding executives and the CEO, we do not find a significant impact of the excess remuneration. This is likely because the Islamic banking industry faces a number of restrictions due to its presence as a heavily regulated financial institution and the voluminous Shariah requirements that must be fulfilled in its operations.